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Sears Holdings Could Head Toward Bankruptcy, and That's OK

Much has been said regarding the ultimate future of Sears Holdings (NASDAQ: SHLD  ) -- whether its retail operations can stabilize, the supposed value of its real estate holdings, and lately, the likelihood of bankruptcy. That last one, the b-word, scares most investors, and not without reason. In some cases, equity holders can get wiped out during bankruptcy proceedings, as debt holders are first in line for liquidation proceeds. But what so many continue to undervalue, and in some cases ignore, is the incredibly rich asset base. While entering bankruptcy would likely mark the end of a 121-year-old retailer, it could showcase what Sears really is -- a real estate and brands business worth a multiple of its market value today.

What it would look like
As Sears' earnings continue to cascade and the company sheds assets to raise additional cash, many analysts and investors (including plenty here at the Fool) are rightfully calling the demise of existing operations. Even though CEO and Chairman Eddie Lampert continues to express optimism about the retail business -- pushing stories about the growing online presence and Shop Your Way loyalty program -- the masses are likely correct in forecasting an eventual end to a longtime mall staple.

But after the Sears sign comes down, the company will still own the property and its names. As has been reported by bulls for years now, the property is worth a ton of money, and arguably much more than Sears' market value today. Sears owns in the neighborhood of 2% of U.S. retail space. Sure, much of that space is in undesirable locations, but a good chunk of it (north of 20%) is highly valuable "A" retail space.

So, in the event of bankruptcy, the interested parties may call for the liquidation of the retail business. Lampert has steadfastly championed the idea of a turnaround, but has mentioned multiple times that he would monetize assets if the situation called for it. As corporate bankruptcies are far more forgiving than personal ones, Sears Holdings could unload some of the more unfavorable debt (retail agreements, etc.) and reorganize the capital structure of the business. With many of its cash-generating assets already out the door, the remaining business could easily transition to a REIT (in addition to the remaining brands). Investors also need to keep in mind that much of the real estate is unencumbered, meaning that the company's debt load is backed not by these assets, but elsewhere. To say that Sears Holdings (note, not Sears the department store) has a liquidity crisis is a mislabeling. Equity investors are not nearly as threatened in a bankruptcy situation as many purport.

Exclusively smart money
In regard to Wall Street as a whole, this is certainly a contrarian opinion. But looking at Sears' major holders in proportion to its outstanding shares paints a rare picture -- more than 95% of the business is owned by some of the smartest investors out there, including Bruce Berkowitz's Fairholme Capital (a near 25% owner), Horizon Kinetics (a renowned value shop whose core fund has averaged a more than 11% annual return since 1996), and, of course, Lampert's own hedge fund, ESL Investments, which, in addition to his personal holdings, owns nearly half of the business.

Bears would say that this collection of billionaires holds on to Sears largely as a point of pride at this point, but that would be extremely out of character for every single one of them.

Wise investors will not try to determine the likelihood of a turnaround, but recognize the liquidation value of the business in comparison to its market value. In many cases, a liquidation figure is irrelevant unless the business is broken up, but that is a distinct possibility here, and therefore the low-end scenario should indeed be break-up value. Few are hoping for miracles with Sears, but even fewer understand that the company doesn't need one.

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Read/Post Comments (6) | Recommend This Article (6)

Comments from our Foolish Readers

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  • Report this Comment On June 08, 2014, at 2:39 PM, Jbrooks130 wrote:

    Is it just me or are these articles about Sears struggling a bit overkill? How many articles can one write about the same topic. Sears is an icon that is trying to survive. They have employees who are just like us, trying to raise there families. Why continue to put the retailer in such a negative light everyday? Why not try to support an American business rather trying to bury it. Yahoo should be ashamed of articles like this.

  • Report this Comment On June 08, 2014, at 6:00 PM, mahmij wrote:

    It's actually amazing. Sears had the best sales reps in the business years ago; they were on commission, knew their products inside and out and sold the crap out of them. Then, they decided to hire a bunch of kids who huddle up and hide if a customer comes in. In the 1980s, Sears was not only a retail giant, but was going to take over banking. It has sold Discover, sold its credit card business to Citi; lost credibility with its customers and is subject to this article. What a shame. Is this a portend for WalMart? You remember, the bigger they are, the harder they fall.

  • Report this Comment On June 09, 2014, at 5:11 PM, jenarogers wrote:

    While real estate and brands like Kenmore, Craftsman, and Die Hard are all part of Sears value, there are some hidden items that don't get discussed.

    The Shop Your Way program has data on tens of millions of customers and their behaviors. Merck bought Medco back in the 1990s to get information on patients and on doctor prescribing patterns, and then their competitors signed deals to sell data to other pharmaceutical companies. This data is an undervalued asset.

    Yes, they are closing big box stores. Who isn't? But Sears could come out with a locally owned franchise store (a la Ben Franklin and True Value) that could thrive in towns of 15,000 to 50,000 people in more rural areas where going to Sears to buy Kenmore appliances is an all day commitment today, possibly using the old SS Kresge brand. That puts Sears in the supplier business.

    What Sears does wrong is marketing for image. They put themselves in a lower tier despite their house brands. Sears could market itself as a 125 year old American institution that sold tools to your grandparents and appliances to your parents. People want to do business with businesses that share their values. But Sears goes out and signs the Kardashians and the Jersey Shore cast and Nikki Minaj and Adam Levine as product endorsers. People might be willing to watch a train wreck on cable TV but they don't want to be associated with it. There's a craving for all that is wholesome and good and Sears could step up and be a store that shows it respects its customer's values. Sears best opportunity to thrive comes from having a marketing theme that consistently drives home the message of wholesome, traditional values. These celebrity endorsers are perceived as contrary to the values Sears needs to promote.

  • Report this Comment On June 11, 2014, at 1:09 PM, 101448 wrote:

    I am sick of reading all the bashing about Sears. If you really want to help this struggling 125 year old retailer, get in touch with the CEO. With the Shop your way program Kmarts prices really cannot be beat. The cheapskates at Walmart need to revisit Kmart and they will see who really has the lowest prices with the membership rewards.

  • Report this Comment On June 13, 2014, at 11:25 PM, Vanmusicblues wrote:

    The RE was written up to full fair market value when thy merged with Kmart . Since then Retail space has declined in value 17%. The brand names no longer hold significant value as new brands hold much more customer appeal associated with quality. Die Hard battery died as a brand of quality 15 years ago. Craftsman is now China tools, a nothing. The big chunk of goodwill on the books is worthless.

    Don't be fooled by this value trap. They will lost 13 dollars per share the next 12 months

  • Report this Comment On January 29, 2015, at 2:53 PM, mbnoyes wrote:

    After my experience with Sears today I went out and shorted the stock.

    After spending 15 minutes in a "chat" yesterday with a service provider to get my dryer fixed today, he was a no show. Called today and was told I did not have an appointment and no evidence I existed. When I asked for a supervisor he hung up on me (did I mention I could barley understand the individual from India). I called back, still could not understand the person and asked for a supervisor. Transferred to Mexico. Through some broken English finally reached an American but the line was so broken up it was difficult to hear.

    Finally a new appointment that may or may not actually happen. After my experience I am skeptical of someone showing up.

    SEARS, what have you become?

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Michael Lewis

Michael is a value-oriented investment analyst with a specific interest in retail and media businesses. Before coming to the Fool, Michael worked with private investment funds focusing on deep value and special situations. Currently living in the media capital of the world--Los Angeles, California.

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8/28/2015 4:00 PM
SHLD $27.30 Up +0.37 +1.37%
Sears Holdings CAPS Rating: *